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United States Government Accountability Office:
GAO:
Report to the Committee on Finance, U.S. Senate:
May 2013:
Virtual Economies and Currencies:
Additional IRS Guidance Could Reduce Tax Compliance Risks:
GAO-13-516:
GAO Highlights:
Highlights of GAO-13-516, a report to the Committee on Finance, U.S.
Senate.
Why GAO Did This Study:
Recent years have seen the development of virtual economies, such as
those within online role-playing games, through which individual
participants can own and exchange virtual goods and services. Within
some virtual economies, virtual currencies have been created as a
medium of exchange for goods and services. Virtual property and
currency can be exchanged for real goods, services, and currency, and
virtual currencies have been developed outside of virtual economies as
alternatives to government-issued currencies, such as dollars. These
innovations raise questions about related tax requirements and
potential challenges for IRS compliance efforts.
This report (1) describes the tax reporting requirements for virtual
economies and currencies, (2) identifies the potential tax compliance
risks of virtual economies and currencies, and (3) assesses how IRS
has addressed the tax compliance risks of virtual economies and
currencies.
To accomplish these objectives, GAO reviewed tax laws, IRS guidance
and program documents, federal program internal control guidance, and
interviewed IRS officials and knowledgeable experts on the topics.
What GAO Found:
Transactions within virtual economies or using virtual currencies
could produce taxable income in various ways, depending on the facts
and circumstances of each transaction. For example, transactions
within a “closed-flow” virtual currency system do not produce taxable
income because a virtual currency can be used only to purchase virtual
goods or services. An example of a closed-flow transaction is the
purchase of items to use within an online game. In an “open-flow”
system, a taxpayer who receives virtual currency as payment for real
goods or services may have earned taxable income since the virtual
currency can be exchanged for real goods or services or readily
exchanged for government-issued currency, such as U.S. dollars.
[Figure: Refer to PDF for image: illustration]
Closed-flow:
Virtual currency:
Virtual good and services.
Open-flow:
Virtual currency:
U.S. dollars;
real good and services;
Virtual good and services.
Source: GAO.
[End of figure]
Virtual economies and currencies pose various tax compliance risks,
but the extent of actual tax noncompliance is unknown. Some identified
risks include taxpayers not being aware that income earned through
virtual economies or currencies is taxable or not knowing how to
calculate such income. Because of the limited reliable data available
on their size, it is difficult to determine how significant virtual
economy and currency markets may be or how much tax revenue is at risk
through their usage. Some experts with whom we spoke indicated a
potential for growth in the use of virtual currencies.
Beginning in 2007, IRS assessed the tax compliance risks from virtual
economies, and in 2009 posted information on its website on the tax
consequences of virtual economy transactions. However, IRS has not
provided taxpayers with information specific to virtual currencies
because of other priorities, resource constraints, and the need to
consider the use of these recently-developed currencies, according to
IRS officials. By not issuing guidance, IRS may be missing an
opportunity to address virtual currency tax compliance risks. Given
the uncertain extent of noncompliance with virtual currency
transactions, formal guidance, such as regulations, may not be
warranted. According to IRS officials, formal guidance requires
extensive review, which adds to development time and cost. However,
IRS may be able to develop more timely and less costly informal
guidance, which, according to IRS officials, requires less extensive
review and can be based on other existing guidance. An example is the
information IRS provides to taxpayers on its website on the tax
consequences of virtual economy transactions. Posting such information
would be consistent with IRS’s strategy for preventing and minimizing
taxpayers’ noncompliance by helping them understand and meet their tax
responsibilities.
What GAO Recommends:
GAO recommends that IRS find relatively low-cost ways to provide
information to taxpayers, such as on its website, on the basic tax
reporting requirements for virtual currencies. In commenting on a
draft of this report, IRS agreed with our recommendation.
View [hyperlink, http://www.gao.gov/products/GAO-13-516]. For more
information, contact James R. White at (202) 512-9110 or
whitej@gao.gov.
[End of section]
Contents:
Letter:
Background:
Virtual Economy and Currency Transactions May Be Taxable If They
Produce Income:
Virtual Economies and Currencies Pose Various Tax Compliance Risks,
but the Extent of Noncompliance Is Unknown:
IRS Has Provided Some Guidance on Tax Reporting Requirements for
Virtual Economies but Not for Virtual Currencies Used Outside of
Virtual Economies:
Conclusions:
Recommendation for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Comments from the Internal Revenue Service:
Appendix II: GAO Contact and Staff Acknowledgments:
Figures:
Figure 1: Types of Virtual Currency Systems:
Figure 2: How Bitcoins Enter Circulation and Are Used in Transactions:
Abbreviations:
EBEI: Electronic Business and Emerging Issues:
IRS: Internal Revenue Service:
MMORPG: massively multiplayer online role-playing game:
[End of section]
United States Government Accountability Office: GAO:
441 G St. N.W.
Washington, DC 20548:
May 15, 2013:
The Honorable Max Baucus:
Chairman:
The Honorable Orrin Hatch:
Ranking Member:
Committee on Finance:
United States Senate:
Recent years have seen the development of virtual economies, such as
those within online role-playing games, through which individual
participants can earn and exchange virtual goods and services. Within
some virtual economies, virtual currencies have been created as a
medium of exchange for goods and services. Virtual property and
currency can have economic value outside of virtual economies, such as
when individuals trade these virtual goods for dollars or other
government-issued currencies. More recently, virtual currencies have
been developed outside of virtual economies as alternatives to
government-issued currencies to exchange for real-world goods and
services. These innovations raise questions about their related tax
requirements and whether their increased adoption could pose
challenges for the Internal Revenue Service (IRS) in its efforts to
ensure tax compliance.
You asked us to review virtual economies and currencies and IRS's
approach to addressing their tax implications. This report's
objectives are to (1) describe the tax reporting requirements for
virtual economies and currencies, (2) identify the potential tax
compliance risks of virtual economies and currencies, and (3) assess
how IRS has addressed the tax compliance risks of virtual economies
and currencies.
To describe reporting requirements for virtual economies and
currencies, we reviewed the Internal Revenue Code and applicable IRS
regulations, including relevant sections of the Internal Revenue
Manual, and interviewed IRS officials. We also reviewed academic
articles and interviewed academics whose research focuses on virtual
currencies and taxation of virtual transactions, as well as tax
practitioners and representatives from the American Institute of
Certified Public Accountants. We selected academics to interview based
on criteria including the recognition and citations of their research
in the relevant literature. We selected tax practitioners and
representatives based on their association with an organization with
widely-recognized expertise in federal tax matters.
To identify potential compliance risks associated with virtual
currencies and virtual economies, we reviewed and analyzed legal and
academic literature and government reports, including the National
Taxpayer Advocate's 2008 Annual Report to Congress and the European
Central Bank's October 2012 report on virtual currencies. We then
discussed these compliance risks with knowledgeable experts, including
the Bitcoin Foundation, a virtual currency user group; tax
professionals, including members of the American Institute of
Certified Public Accountants; representatives from a company that
publishes a virtual economy platform; and academics who have written
about virtual currencies and taxation of virtual economy transactions.
We selected experts based on criteria including their recognition and
citations in the literature, and their expertise and recognition in
representing taxpayers in federal tax matters or in representing
virtual economy or currency concerns. We interviewed IRS officials
knowledgeable on virtual economies and currencies and overall IRS tax
compliance enforcement efforts. We also performed Internet searches to
see what information was circulating for determining the proper tax
treatment of virtual economy and currency transactions.
To assess how IRS has addressed compliance risks, we reviewed IRS
documentation, including training manuals, examination guides, and
internal reports detailing compliance challenges posed by virtual
economies. We also interviewed knowledgeable IRS staff on the agency's
efforts to learn about virtual economies and currencies and address
them through compliance efforts. We compared IRS's efforts to federal
program management guidance on gathering and monitoring information to
identify and assess program risks, including the internal control
standards for federal government and our Internal Control Management
and Evaluation Tool.[Footnote 1] Such guidance stipulates that
agencies should have adequate mechanisms to identify risks to agency
programs arising from external factors and that agencies should
consider and, if appropriate, address the risks associated with
technological advancements and developments and risks resulting from
business and economic changes, among other types of changes. We also
reviewed general IRS procedures and plans for providing information to
taxpayers to help them comply with tax requirements included in IRS's
Taxpayer Assistance Blueprint and related progress reports to
Congress.[Footnote 2]
We conducted this performance audit from September 2012 to May 2013 in
accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives.
Background:
There are no legal definitions for a virtual economy or currency, but
generally, a virtual economy is comprised by the economic activities
among a community of entities that interact within a virtual setting,
such as an online, multi-user game. Virtual economies can be closed,
meaning the economic activities and units of exchange used within the
community do not interact with the real economy outside of the virtual
environment setting, or they can be open, with some economic activity
occurring in both the virtual setting and the real economy. A virtual
currency is, generally, a digital unit of exchange that is not backed
by a government-issued legal tender. Virtual currencies can be used
entirely within a virtual economy, or can be used in lieu of a
government-issued currency to purchase goods and services in the real
economy. Some virtual economies may function similarly to barter
exchanges,[Footnote 3] where bartering is the exchange of goods or
services in lieu of monetary payments. For example, a carpenter may
build a desk for a dentist in exchange for dental work. Barter
transactions are taxable transactions, and taxpayers must report the
fair market value of the good or service received on their tax
returns. Some of the variations in virtual currencies and their
interaction with the real economy are shown in figure 1.
Figure 1: Types of Virtual Currency Systems:
[Refer to PDF for image: illustration]
Closed-flow:
Virtual currency: flows to:
Virtual good and services.
Virtual currency can be used to purchase virtual goods or services
only. There is no interaction between the virtual currency and U.S.
dollars or real goods and services.
Hybrid:
Virtual currency:
Receives U.S. dollars;
Flows to Real good and services;
Receives and flows to Virtual good and services.
Virtual currency can be used to purchase virtual goods or services and
may be used to purchase real goods or services. In some hybrid
systems, users can purchase virtual currency with U.S. dollars.
Open-flow:
Virtual currency:
U.S. dollars;
Real good and services;
Virtual good and services.
Virtual currency can be used to purchase both real and virtual goods
and services and the virtual currency is freely exchangeable with U.S.
dollars.
Source: GAO.
[End of figure]
In a "closed-flow" virtual currency system, a virtual currency can be
used only within a game or virtual environment to purchase virtual
goods or services, such as additional tools to use within a game.
Virtual tools amassed by players can be traded in a game for other in-
game assets or to advance to higher play levels, but they hold no
value outside of the game and cannot be cashed out for dollars or
other government-issued currencies.
In a hybrid system, one or more of the flows between the virtual
currency and real dollars or goods and services is closed. For
example, participants can purchase virtual currency with real dollars
or earn virtual currency by completing tasks, such as taking surveys,
and then use the currency to purchase real or virtual goods and
services. However, the virtual currency might not be exchangeable back
into real dollars. An example of a hybrid system is some massively
multiplayer online role-playing games (MMORPG). MMORPGs allow users to
create avatars, or graphical representations of themselves, that exist
within a digital world and interact with other avatars around the
globe to carry out tasks. Some MMORPGs operate as a closed-flow
system, but some of these closed-flow systems can leak into the real
economy via third-party transactions. Some MMORPGs, like World of
Warcraft®, a large MMORPG, have third-party exchanges that allow users
to exchange virtual goods for real dollars. This interaction between
the virtual and real economies can be limited by the game's
distributor through terms of use agreements.
In an "open-flow" system, virtual currencies can be used to purchase
both real and virtual goods and services, as well as be readily
exchanged for government-issued currency, such as U.S. dollars. One
example of an open-flow currency designed primarily for use in a
virtual economy is Second Life® LindenTM dollars. Second Life, a
product of Linden Lab®, is a virtual economy created in 2003 that has
its own virtual currency. "Residents" of Second Life create avatars
and interact with other avatars in a user-defined and user-created
environment. Within Second Life, residents can create virtual assets,
such as buildings that they rent or sell to other residents, or
operate virtual businesses, such as virtual clothing stores that sell
virtual goods to other residents. Transactions taking place within
Second Life use Linden Lab's virtual currency, Linden dollars. Second
Life residents can sell their Linden dollars to other residents for
U.S. dollars through the LindeXTM exchange, which uses third-party
payment networks to process the payments and allows residents to cash
out of the Second Life world.
An open-flow currency can also be developed and designed primarily to
be used to purchase real goods and services outside an online game
virtual economy. An example is bitcoin, a decentralized digital
currency that uses a peer-to-peer computer network to move bitcoins
around the world. Developed in 2009 by an anonymous programmer or
programmers, bitcoin is a privately-issued digital currency that
exists only as a long string of numbers and letters in a user's
computer file. Bitcoins use cryptography to secure and safeguard
against counterfeiting. Unlike U.S. dollars and other currencies,
bitcoin is not government issued and does not have a physical coin or
bill associated with its circulation, such as a Federal Reserve note.
Bitcoin has grown in popularity since its introduction and, according
to academics and user groups with whom we spoke, is the most widely
circulated virtual currency available. Bitcoins act as a real world
currency in that users pay for real goods and services, such as coffee
or web development services, with bitcoins as opposed to U.S. dollars
or other government-issued currencies. Third-party exchanges allow
bitcoin users to exchange their bitcoins back to government-issued
currencies, such as U.S. dollars, euro, or yen.
Bitcoins are created and entered into circulation through a process,
called mining, that members of the bitcoin network perform. To perform
the work of mining, bitcoin miners download free bitcoin software that
they use to solve complex equations. These equations serve to verify
the validity of bitcoin transactions by grouping several transactions
into a block and mathematically proving that the transactions occurred
and do not represent double spending of a bitcoin. When a miner's
computer solves an equation, the bitcoin network accepts the block of
transactions as valid and creates 25 new bitcoins and awards them to
the successful miner.[Footnote 4] By the bitcoin program's design,
there will be a maximum of 21 million bitcoins in circulation once all
bitcoins have been mined, which the program's design projects to be in
the year 2140. In addition to mining new bitcoins, users can also
acquire bitcoins already in circulation by purchasing them on third-
party exchanges or accepting bitcoins as gifts or payments for goods
or services. Figure 2 shows an example of how bitcoins enter
circulation and how an individual can use bitcoins to pay for real
goods or services.
Figure 2: How Bitcoins Enter Circulation and Are Used in Transactions:
[Refer to PDF for image: illustration]
Bitcoins enter into circulation through a process known as mining.
Bitcoin Addresses:
A bitcoin address comprises a paired private key and public key. The
private key is stored in a wallet and known only to the bitcoin
address owner, who uses the private key to conduct a transaction. The
public key associated with the bitcoin address is public information.
Bitcoin miners use the public key to verify a transaction is valid,
which avoids double spending of a bitcoin.
1. Mining:
Bitcoins first enter into circulation through a process known as
mining. Bill installs bitcoin mining software on his computer which he
uses to solve complex equations for the bitcoin network. If Bill
successfully solves an equation, he receives a block of 25 bitcoins.
Bitcoins come in the form of a long string of numbers and letters,
known as a bitcoin address. Each bitcoin address is unique.
2. Wallets and Addresses:
Bill stores his bitcoins in a bitcoin wallet, which is a program that
saves bitcoin addresses, on a hard drive, on the internet, or another
data storage device. Bitcoin users can have multiple wallets, each
wallet can hold multiple addresses, and each address holds a balance
of bitcoins.
3. Making a Purchase with Bitcoins:
Bill wants to buy a t-shirt from Carol, who accepts bitcoins. To
conduct the transaction, Carol sends her bitcoin address to Bill. Bill
instructs his wallet to send a payment to Carol’s address.
4. Verifying the Transaction:
The transaction is bundled with other transactions and verified by the
bitcoin mining community in blocks. Solving complex equations, miners
verify the transactions to ensure the transactions are valid and the
transactions are then locked and added to the permanent bitcoin
history, or block chain, eventually making the transactions
irreversible.
5. Transaction Complete:
Bill’s bitcoins are credited to Carol’s address within minutes, and
the bitcoin transaction is complete. The miner that successfully
solved the equations to verify the block containing Bill and Carol’s
transaction is rewarded with 25 bitcoins.
Source: GAO.
[End of figure]
Bitcoin transactions can be anonymous, since all that is needed to
complete a transaction is a bitcoin address, which does not contain
any personal identifying information. Only the private key holder
knows the identity of the bitcoin address owner.
The size of the virtual economy and currency markets is unclear due to
limitations in available data. For example, some companies that offer
virtual economy platforms are private firms and do not report
statistics about their virtual worlds' activities. Further, due to the
global nature of the Internet, borderless transactions, and an
individual's ability to have multiple virtual economy or currency
accounts, we did not find reliable data available indicating the use
of virtual economies or currencies by individuals or exclusively by
U.S. taxpayers.[Footnote 5] Even with these limitations, some data
exist that may provide some context for the size of virtual economy
and currency markets.
* According to bitcoin's peer-to-peer-network-generated statistics,
[Footnote 6] as of May 1, 2013, approximately 11 million bitcoins were
in circulation.[Footnote 7] Bitcoin exchange rates against the U.S.
dollar historically have been volatile. From May 2012 through February
2013, prices ranged between $5 and $20 for 1 bitcoin. Prices increased
through March 2013, and then from April 1, 2013, to May 1, 2013,
ranged between $79 and over $237 for 1 bitcoin.[Footnote 8] In the
same time period, the number of bitcoin transactions per day ranged
from approximately 8,000 to 70,000 transactions per day.
* As of December 31, 2012, there were over 9.6 million active users of
World of Warcraft, a large MMORPG, according to Blizzard
Entertainment®, the company that develops and publishes the World of
Warcraft games.
* According to Linden Lab, creators of Second Life, residents
exchanged more than US$150 million worth of Linden dollars within
Second Life's economy in the third quarter of 2010.
IRS is responsible for ensuring taxpayer compliance for all economic
areas, including virtual economies and currencies. One mechanism that
assists IRS in enforcing tax laws is information reporting, through
which third parties report to IRS and taxpayers on certain taxpayer
transactions. For example, subject to certain thresholds, third-party
settlement organizations are required to report on Form 1099-K
payments in settlement of third-party network transactions.[Footnote
9] A common example of a third-party settlement organization is an
online auction-payment facilitator, which operates as an intermediary
between buyers and sellers by transferring funds between their
accounts in settlement of purchases. Another type of third-party
information reporting is performed by barter exchanges, which,
generally, are organizations that facilitate barter transactions among
exchange members. Such barter exchanges are required to report on Form
1099-B each member's barter transactions proceeds. Third-party
information reporting is widely acknowledged to increase voluntary tax
compliance, in part because taxpayers know that IRS is aware of their
income.
Likewise, in its role in administering the tax code, IRS must
implement the laws Congress enacts through detailed guidance. To
accomplish this responsibility, IRS publishes several forms of
guidance, such as regulations, revenue rulings and procedures, and
notices. IRS also provides more informal guidance on its website based
on factors such as perceived need, media coverage, or IRS staff
identifying an emerging tax compliance issue. As outlined in IRS's
Taxpayer Assistance Blueprint and related reports, a key part of IRS's
strategy for preventing and minimizing noncompliance is to outreach to
taxpayers to help them understand and meet their tax responsibilities.
One of the guiding principles of this approach is to enhance IRS's
website so that it becomes the first choice of taxpayers for obtaining
the information they need to comply.
Virtual Economy and Currency Transactions May Be Taxable If They
Produce Income:
Transactions within virtual economies or using virtual currencies
could produce taxable income in a number of ways depending on their
specific facts and circumstances. U.S. tax laws and regulations
generally require taxpayers to report and pay taxes on all income,
regardless of the source from which the income was derived;[Footnote
10] there are no additional rules specific to virtual currencies or
economies. For example, similar to cash transactions, there are no
third-party reporting requirements specific to virtual economy or
currency transactions, as there are with some other types of
electronic funds transactions, such as with transactions conducted
through third-party payment networks. Taxpayers are required to
account for any taxable income, including income that is not subject
to third-party information reporting. The following examples show how
some taxpayers may incur a tax liability when using a virtual currency
for the three types of virtual currency systems described in the
background of this report. We discussed these examples with IRS
officials, who agreed with how we characterized the potential tax
implications.
* David plays an online game through which he is issued money that he
can use to purchase properties within the game. These properties have
no value outside the game and David cannot exchange his online money
for U.S. dollars. David has not engaged in a taxable transaction.
* Ann plays an online game and amasses virtual tools that are valuable
to her avatar. The online game does not allow users to directly
exchange their virtual tools for U.S. dollars, but rather they can do
so using a third-party, making this a hybrid system. Ann uses a third-
party exchange not affiliated with the online game to coordinate the
transfer of her virtual tools to another player in exchange for U.S.
dollars. The transfer is conducted by the third-party exchange and
payment is mediated by a third-party payment network. Ann may have
earned taxable income from the sale of these virtual tools.
* John is a resident of Second Life. He rents virtual property to
other residents who pay him in Linden dollars. At the end of the year,
John exchanges his Linden dollars for U.S. dollars and realizes a
profit. John may have earned taxable income from his activities in
Second Life.
* Bill is a bitcoin miner. He successfully mines 25 bitcoins. Bill may
have earned taxable income from his mining activities.
* Carol makes t-shirts and sells them over the Internet. She sells a t-
shirt to Bill, who pays her with bitcoins. Carol may have earned
taxable income from the sale of the t-shirt.
Virtual Economies and Currencies Pose Various Tax Compliance Risks,
but the Extent of Noncompliance Is Unknown:
IRS, tax experts, academics, and others have identified various tax
compliance risks associated with virtual economies and currencies,
including underreporting, mischaracterization, and evasion. These
risks are not unique to virtual economies and currencies, as they also
exist for other types of transactions, such as cash transactions,
where there are not always clear records or third-party tracking and
reporting of transactions. The tax compliance risks we identified for
virtual economies and currencies are described below.
* Taxpayer lack of knowledge of tax requirements. Income is generally
defined as any undeniable accessions to wealth, clearly realized, and
over which the taxpayers have complete dominion.[Footnote 11] The
unsophisticated taxpayer may not properly identify income earned
through virtual economies or currencies, such as virtual online game
assets exchanged for real word currency, as taxable income. If
taxpayers using virtual currencies turn to the Internet for tax help,
they may find misinformation in the absence of clear guidance from
IRS. For example, when we performed a simple Internet search for
information on taxation of bitcoin transactions, we found a number of
websites, wikis, and blogs that provided differing opinions on the tax
treatment of bitcoins, including some that could lead taxpayers to
believe that transacting in virtual currencies relieves them of their
responsibilities to report and pay taxes.
* Uncertainty over how to characterize income. Even if taxpayers are
aware that they may have a tax liability, they may be uncertain about
the proper tax treatment of virtual transactions, according to tax
experts, including academics and tax practitioners with whom we spoke.
For example, characterization depends on whether the virtual economy
activity or virtual currency unit is to be treated as property,
barter, foreign currency, or a financial instrument. According to some
experts with whom we spoke, some virtual currency transactions could
be considered barter transactions, which may not be an obvious
characterization to unsophisticated taxpayers.[Footnote 12] This
characterization could result in noncompliance with requirements for
reporting and paying tax on barter income.
* Uncertainty over how to calculate basis for gains. Income earned
from virtual economy or currency transactions may not be taxable if it
is equivalent to that from an occasional online garage sale, meaning
occasional income from selling goods for less than their original
purchase price. It may be difficult for individuals receiving income
from virtual economies to determine their basis for calculating gains.
For example, some online games require players to pay a monthly fee in
exchange for use of the game and a monthly allowance of virtual
currency. If a player then sells a virtual tool gained in the game for
real money, calculating the basis for any taxable gain may be
difficult for the unsophisticated taxpayer.
* Challenges with third-party reporting. Third-party information
reporting requirements do not apply specifically to transactions using
virtual economies or currencies. Virtual economy or currency
transactions may be subject to third-party information reporting to
the extent that these transactions involve the use of a third-party
payment network to mediate the transaction and the taxpayer meets
reporting threshold requirements.[Footnote 13] Because virtual economy
and currency transactions are inherently difficult to track, including
identifying the true identities of the parties to the transaction,
third-party information reporting may be difficult or prohibitively
burdensome for some virtual economy and currency issuers to administer.
* Evasion. Some taxpayers may use virtual economies and currencies as
a way to evade taxes. Because transactions can be difficult to trace
and many virtual economies and currencies offer some level of
anonymity, taxpayers may use them to hide taxable income.
Because of the limited reliable data available on their size, it is
difficult to determine how significant virtual economy and currency
markets may be or how much tax revenue is at risk through their usage.
Some experts with whom we spoke indicated that there is potential for
growth in the use of virtual currencies. Additionally, the European
Central Bank recently issued a report on virtual currencies,
acknowledging their potential for future growth and interaction with
the real economy.[Footnote 14] If the use of virtual economies and
currencies expands, it can be expected that associated revenue at risk
of tax noncompliance will grow.
IRS Has Provided Some Guidance on Tax Reporting Requirements for
Virtual Economies but Not for Virtual Currencies Used Outside of
Virtual Economies:
IRS has assessed the tax compliance risks from virtual economies and
virtual currencies used within those economies, and developed a plan
to address them in a manner consistent with internal control
standards. Beginning in 2007, IRS's Electronic Business and Emerging
Issues (EBEI) policy group identified and surveyed internal and
external information sources, gathered data on the industry, and
collect trend information, among other efforts. EBEI determined that
virtual economies presented opportunities for income underreporting
and developed (1) a potential compliance strategy, including
initiating a compliance improvement project to gather research data
and analyze compliance trends, and (2) a potential action plan for
specific compliance activities. According to IRS compliance officials,
IRS ultimately decided not to pursue these actions in light of
available IRS resources and other higher priority needs. Also, IRS did
not find strong evidence of the potential for tax noncompliance
related to virtual economies, such as the number of U.S. taxpayers
involved in such activity or the amount of federal tax revenue at risk.
However, in November 2009, based on EBEI having determined the need,
IRS posted information on its website on the tax consequences of
virtual economy transactions. The web page points out that, in
general, taxpayers can receive income in the form of money, property,
or services from a virtual economy, and that if taxpayers receive more
income than they spend, they may be required to report their gains as
taxable income. The page further states that IRS has provided guidance
on the tax treatment of issues similar to online gaming activities,
including bartering, gambling, business, and hobby income, and
provides links to IRS publications on those topics. IRS officials who
were involved in issuing this guidance reported it cost less to make
an online statement pointing taxpayers to existing guidance than it
would have cost to develop and publish new guidance specific to
virtual economies.
IRS has not assessed the tax compliance risks of open-flow virtual
currencies developed and used outside of virtual economies. These
types of currencies, generally, were introduced after IRS's last
review of compliance related to virtual economy transactions.
According to IRS compliance officials, IRS would learn about tax
compliance issues related to virtual currencies as it would any other
tax compliance issue, such as IRS examiners identifying compliance
problems during examinations or taxpayers requesting guidance on how
to comply with certain tax requirements. To date, these processes have
not resulted in IRS identifying virtual currencies used outside of
virtual economies as a compliance risk that warrants specific
attention.
Likewise, IRS has not issued guidance specific to virtual currencies
used outside of virtual economies due to competing priorities and
resource constraints, and because the use of virtual currencies is a
relatively recent development that requires further consideration
before guidance can be issued, according to IRS's Office of Chief
Counsel and compliance officials.[Footnote 15] As previously
discussed, taxpayers may be unaware that income from transactions
using this type of virtual currency may be taxable, or if they are
aware, uncertain on how to characterize it. By not issuing guidance,
IRS may be missing an opportunity to address these compliance risks
and minimize their impact and the potential for noncompliance. Given
the uncertain extent of noncompliance related to virtual currency
transactions, formal guidance, such as regulations, revenue rulings,
or revenue notices, may not be warranted at this time. According to
officials from IRS's Office of Chief Counsel, these types of guidance
require extensive review within IRS and the Department of the Treasury
and, in some cases, public comment, which add to the time and cost of
development. However, IRS may be able to develop informal guidance,
which, according to Chief Counsel officials, requires less extensive
agency review and can be based on other existing guidance. As such,
IRS can develop informal guidance in a more timely and less costly
manner than formal guidance, according to the officials. An example of
such informal guidance is the information IRS provides to taxpayers on
its website on the tax consequences of virtual economy transactions.
Posting such information to its website would be consistent with IRS's
strategy for preventing and minimizing taxpayers' noncompliance by
helping them understand and meet their tax responsibilities, as
outlined in IRS's Taxpayer Assistance Blueprint.
Conclusions:
Virtual economies and the use of virtual currencies intended as
alternatives to government-issued currencies are a recent phenomenon,
and the extent to which their use results in tax noncompliance is
unknown. Given this uncertainty, available funding, and other
priorities, IRS made a reasoned decision not to implement a compliance
approach specific to virtual economies and currencies. However, IRS
did see value in providing taxpayers with information on the tax
consequences of virtual economy transactions, a low-cost step to
potentially mitigate some of the noncompliance risk associated with
such transactions. The uncertainty about the extent virtual currencies
are used in taxable transactions and any associated tax noncompliance
means that costly compliance activities are not merited at this time.
However, the fact that misinformation is circulating and the
possibility of growth in the use of virtual currencies outside virtual
economies suggest that it would be prudent to take low-cost steps, if
available, to mitigate potential compliance risks. The type of
information IRS provided about virtual economy transactions is one
model.
Recommendation for Executive Action:
To mitigate the risk of noncompliance from virtual currencies, the
Commissioner of Internal Revenue should find relatively low-cost ways
to provide information to taxpayers, such as the web statement IRS
developed on virtual economies, on the basic tax reporting
requirements for transactions using virtual currencies developed and
used outside virtual economies.
Agency Comments and Our Evaluation:
We sent a draft of this report to the Acting Commissioner of Internal
Revenue for comment. In written comments, reproduced in appendix I,
IRS agreed with our recommendation and stated it would provide
information to taxpayers on the basic tax reporting requirements for
transactions involving virtual currencies by linking to existing
relevant guidance. IRS noted that it was aware of the tax compliance
risks associated with virtual currencies and was taking other steps,
such as developing training resources for agents, to address them. IRS
also provided technical comments on our draft report, which we
incorporated, as appropriate.
As agreed with your offices, unless you publicly announce the contents
of this report earlier, we plan no further distribution until 30 days
from the report date. At that time, we will send copies to interested
congressional committees, the Secretary of the Treasury, the Acting
Commissioner of Internal Revenue, and other interested parties. In
addition, the report also will be available at no charge on the GAO
website at [hyperlink, http://www.gao.gov].
If you or your staff have any questions about this report, please
contact me at (202) 512-9110 or whitej@gao.gov. Contact points for our
Offices of Congressional Relations and Public Affairs may be found on
the last page of this report. GAO staff who made key contributions to
this report are listed in appendix II.
Signed by:
James R. White:
Director, Tax Issues:
Strategic Issues:
[End of section]
Appendix I: Comments from the Internal Revenue Service:
Department of the Treasury:
Internal Revenue Service:
Deputy Commissioner:
Washington, D.C. 20224:
May 3, 2013:
Mr. James R. White:
Director, Tax Issues:
Strategic Issues Team:
U.S. Government Accountability Office:
441 G. Street NW:
Washington, DC 20548:
Dear Mr. White:
Thank you for the opportunity to review your draft report entitled,
"Virtual Economies and Currencies: Additional IRS Guidance Could
Reduce Tax Compliance Risks" (GAO 13-516). We are pleased your report
acknowledges the Service's efforts to provide taxpayers with
information on the tax consequences of virtual economy transactions by
posting information on our website and providing links to existing IRS
guidance on bartering, gambling, business, and hobby income.
As your report notes, we began evaluating the tax compliance risks
associated with virtual economies and virtual currencies in 2007.
Although the Service did not specifically use the term "virtual
currency," which was not well-defined at the time, this evaluation
included all types of electronic payment systems. The systems
evaluated included what is now covered by the term "virtual currency"
whether used inside or outside the virtual world.
The Service is aware of the potential tax compliance risks posed by
off-shore and anonymous electronic payment systems, and we are working
to address these risks. Our efforts have included discussions with
other federal agencies, evaluating our agents' expertise, developing
continuing professional education curricula, providing online and
classroom training, and creating lead sheets and questionnaires for
agent use during examinations.
We agree that providing taxpayers with information on the basic tax
reporting requirements for transactions involving virtual currencies
could further aid our efforts. The enclosed response addresses your
recommendation.
If you have questions, please call me, or members of your staff may
contact Faris Fink, Commissioner, Small Business/Self Employed
Division at (202)622-0600.
Sincerely,
Signed by:
Steven T. Miller:
Deputy Commissioner for Services and Enforcement:
Enclosure:
GAO Recommendation and IRS Response to GAO Draft Report: Virtual
Economies And Currencies: Additional IRS Guidance Could Reduce
Tax Compliance Risks (GAO-13-516).
Recommendation:
To mitigate the risk of noncompliance from virtual currencies, the
Commissioner of Internal Revenue should find relatively low-cost ways
to provide information to taxpayers - such the Web statement IRS
developed on virtual economies - on the basic tax reporting
requirements for transactions using virtual currencies developed and
used outside virtual economies.
Comment:
We will provide information to taxpayers on the basic tax reporting
requirements for transactions involving virtual currencies by linking
to existing relevant guidance.
[End of section]
Appendix II: GAO Contact and Staff Acknowledgments:
GAO Contact:
James R. White, (202) 512-9110 or whitej@gao.gov:
Staff Acknowledgments:
In addition to the contact named above, Jeff Arkin (Assistant
Director), David Dornisch, Lois Hanshaw, Richard Hung, Ronald W.
Jones, Donna Miller, Ed Nannenhorn, Danielle N. Novak, and Sabrina
Streagle made key contributions to this report.
[End of section]
Footnotes:
[1] GAO, Internal Control Management and Evaluation Tool, [hyperlink,
http://www.gao.gov/products/GAO-01-1008G[ (Washington, D.C.: August
2001).
[2] The 2007 Taxpayer Assistance Blueprint--a 5-year strategic plan
for improving service to taxpayers--is a collaborative effort of IRS,
the National Taxpayer Advocate, and the IRS Oversight Board. Congress
has received annual update reports on the implementation of the
blueprint.
[3] The term "barter exchange" means any organization of members
providing property or services who jointly contract to trade or barter
such property or services. 26 U.S.C. § 6045.
[4] According to bitcoin's design, the number of bitcoins issued to
successful miners will halve every time the network reaches 210,000
blocks, or approximately every four years. From inception through
November 2012, rewards were 50 bitcoins. In 2016, rewards are expected
to halve again to 12.5 bitcoins.
[5] Given these limitations, we did not test the reliability of data,
such as the data generated from the bitcoin network, but are providing
some figures to provide context for the possible size of these markets.
[6] [hyperlink, http://blockchain.info]. (Date accessed May 1, 2013.)
[7] Due to data limitations, it is difficult to calculate the
velocity, or the rate at which bitcoins are spent, and the number of
transactions between unique users in a given time period.
[8] [hyperlink, https://mtgox.com]. (Date accessed May 1, 2013.)
https://mtgox.com operates the largest bitcoin exchange. The site has
daily and monthly limits on how many bitcoins may be exchanged back to
U.S. dollars or other virtual or government-issued currencies. These
limits may be raised if users provide additional documentation
confirming their identity.
[9] Third-party settlement organizations must file Form 1099-K if
gross payments to a payee exceed $20,000 and there are more than 200
transactions with the payee in a given tax year.
[10] For federal tax purposes, all income is taxable, although the tax
code excludes some items from income, such as gifts or inheritances,
subject to exceptions, while it allows other items to be deducted to
reduce taxable income, subject to limitations and restrictions, such
as trade or business expenses.
[11] Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955).
[12] 26 U.S.C. § 6045 addresses barter exchanges and barter
transactions.
[13] 26 U.S.C. § 6050W and applicable regulations define third-party
payment networks.
[14] European Central Bank, Virtual Currency Schemes (Frankfurt am
Main, Germany: October 2012).
[15] Although IRS has not issued guidance, another Department of the
Treasury agency, the Financial Crimes Enforcement Network, recently
issued interpretive guidance clarifying the treatment of persons
creating, obtaining, distributing, exchanging, accepting, or
transmitting virtual currencies. However, such guidance does not
discuss the tax treatment of virtual currency transactions. FIN-2013-
G001.
[End of section]
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